An asset owner, money manager and academic faced off in a panel discussion at the Council of Institutional Investors conference in Los Angeles expressing widely different views on the degree of toughness investors should bring to bear to demand better corporate governance at technology companies coming to the market.
“The U.S. is on track for its biggest year in initial public offerings since 2000,” with tech companies, many based in Silicon Valley, leading “the way in number of deals and capital raised,” Jennifer O'Dell, assistant director of corporate affairs of the $991 million Laborers' International Union of North America Staff and Affiliates Pension Fund, Washington, said introducing the panel.
“But many of these young public companies have corporate governance structures at odds with best practices that CII members and other institutional investors have endorsed.”
Among issues raised during the panel discussion Sept. 30 are:
- differences on how strictly the governance structure of new companies should adhere to best practices compared with mature companies;
- lack of trust between institutional investors and entrepreneurs;
- resistance of top-tier venture capital managers to the correlation of good corporate governance and corporate performance; and
- limited capability and willingness of pension funds and other institutional investors, even with their huge assets, to withhold investing to bargain for better corporate governance terms when venture capitalists can reach out to vaster global sources of capital.
“The markets are not behaving with respect to hot IPOs as if corporate governance matters,” said F. Daniel Siciliano, professor of the practice of law and faculty director, Arthur and Toni Rembe Rock Center for Corporate Governance, Stanford University Law School, Stanford, Calif. Investors “have to take that to heart.”
Anne Simpson, senior portfolio manager and director of global governance at the $294.2 billion California Public Employees' Retirement System, Sacramento, was skeptical of compromising corporate governance principles but acknowledged the primacy of economics.
“For us, governance is fundamental,” Ms. Simpson said at the Sept. 30 panel. Governance “is important for risk management. It sets the stage for improved and sustained performance. We don't distinguish whether that's a good idea for a small company, a medium (company) or a big company.” Governance “is a fundamental part of being a well-run business.”
When CalPERS provides capital, governance “is also the mechanism which protects us,” Ms. Simpson said. In the pre-IPO or IPO stage or whatever phase of ownership structure, CalPERS will “be raising these issues” of good corporate governance practice, she said.
But CalPERS doesn't avoid investing in companies because of governance issues, Ms. Simpson added: “We buy when there is an opportunity that matches our view of the economics. But we will then be consistently a voice for improvement” of governance.
Anne Chapman, vice president, Capital Group, who oversees proxy voting of American Funds Group said company analysts focus on financial prospects in making IPO investment decisions.
Mr. Siciliano said venture-capital-funded companies “exist in a relatively ungovernance space.”
Because companies are successful, “they have a lot of power … to lay out the corporate governance they want,” Mr. Siciliano said.
“Portfolio managers, when confronted with that (power) … are very anxious about missing out (on an IPO over governance issues) and looking bad for not grabbing on to” an IPO, Mr. Siciliano said. There is “the fear factor for missing outlier performance.”
“If you told your portfolio managers, 'We have a rule … you cannot invest no matter what the financial (prospects) in a company that does A, B or C (in governance practices),' I would be interested in what happens,” he added.
Ms. Simpson said tougher corporate governance listing standards could level the playing field among investors.
But even large pension funds have little sway over new companies now.
“Markets are so global and so big,” she said, that “to just say 'No, I won't play', I don't think it's actually going to have an impact on these companies” to raise capital.
“It's very hard for us as major investors to run around and change the rules of the game,” Ms. Simpson said. “It's the stock exchange's job.”
In terms of improving corporate governance at IPO companies, Ms. Chapman suggested a gradual approach.
Analysts at Capital Group “consider companies in certain sectors … that have a really long (research and development) ramp-up, to be somewhat different than others in the marketplace” in regard to corporate governance, Ms. Chapman said. So it's not “unreasonable to think about early stage as a little bit different (in governance). They may be … in a particularly fragile moment in time. They may need some additional flexibility in order to see their ideas through.”
“There should be some case-by-case” differences in governance, Ms. Chapman added. “You should apply some judgment to companies in all stages” of their development.
Ms. Simpson disagreed.
“Once you are a public company, you are a grown-up and you're ready for prime time,” Ms. Simpson said. “You are taking the public's money. And the governance practices that we want (include) an independent, diverse, competent board, accountable to the providers of capital. What is it about that that is so troubling?”
Mr. Siciliano responded: “It may not be right to call them full adults just because” the companies tap the public market to sell stock. “I really think they may be adolescents … The good thing about teenage adolescents is they don't think anything can kill them. They're inclined to take extraordinary … risks to have breakthroughs to success.
“You should think of them as adolescents and hope to get them to adulthood,” Mr. Siciliano said. “But I do think the one-size-fits-all (governance concept) backfires.”
“At best (these new tech companies) have a very wary and … antagonistic relationship with the concept of investors,” Mr. Siciliano said. Typically the companies have “a very successful founder who has played games and cleverly strategized to keep … as much control as they can. They don't have a sense of trust” with shareholders.
“So trade up for power” over governance, he said. “If they perform badly over a long period of time, have that be the triggering” mechanism to strengthen governance and “treat them like an adult now.”
Donna Anderson, vice president and global governance analyst at T. Rowe Price Group Inc., who chairs its proxy-voting committee and leads engagement efforts with portfolio companies — and moderated the panel discussion — wondered if governance maturation process should be performance based.
Ms. Simpson called performance-based triggers “a fair-weather provision,” adding shareholders need “an all-weather provision.”
“That's like tossing the car keys to the teenager,” Ms. Simpson said. “The reason we have boards is that so we have adults in the room … So, grownups on the board, teenagers in the engine room doing fabulous things.”
Ms. Chapman said it's “a judgment call” on whether an investor at times “could live with a classified board or … poison pill.”
“Taking a very standard (tougher) view on corporate governance makes the very best pre-IPO companies a little anxious,” Mr. Siciliano said. “The capital available to private companies is such that they can go longer and grow even bigger” without selling public shares.
Leaders at new companies “are not saying 'We don't care about shareholders,'” Mr. Siciliano said. “They're saying 'We know better.'”
Ms. Anderson asked: “Is it arrogance on their part that they (companies) just know better than we (shareholders) do? Or it is arrogance on our (shareholders') part to assume that they should fall in line” to adopt good governance?
Ms. Simpson said shareholders like CalPERS need to “show grit and determination” in the face of governance setbacks, by continuing to speak up from the first sign of a new need for improvement, enlisting other institutional investors to the cause of better governance and persisting in the face of companies rejecting proposals for change.
However, that doesn't translate with private equity.
“We are not typically in a position to dictate this (governance) structure of private equity because of the lack of control of investing through limited partnerships,” Ms. Simpson said.
“There is nothing in a private equity investor's mind other than economics,” Ms. Simpson said. “If we argue the economic interest around good governance … I don't think that (private equity) community) even has this on their agenda.”
Mr. Siciliano said, “That is a collective action problem. … At least right now one of the challenges with motivating venture capitalists to change their behavior (on governance) by (asset owners) trying to restrict the capital they (can access is) that the very best VCs are very much over funded … So anyone who kicks up any fuss would be left out.”
Venture capital manages can access capital from lots of other sources such as private wealth managers or sovereign wealth funds, Mr. Siciliano said.
“I would say the vast majority of venture capitalists are very profit seeking, extraordinarily aggressive and on a good day kind of legally bound but amoral,” Mr. Siciliano said. “That means … the legal standard should not be the standard” for governance.
“A lot of entrepreneurs really do arrive at the successful pre-IPO point … afraid of what the investor will do to them (and) not (realizing) that the investor can help them or guide them,” Mr. Siciliano said.
